High-risk, high-return investments are incredibly popular, especially among traders. In most cases, an investment with a high potential return also comes paired with significant risk. Similarly, instruments such as high-grade bonds, which have historically offered mediocre gains, provide an elevated level of security and stability thanks to their low risk.

While it’s possible to create a large nest egg using bonds, it takes a long time. And for those seeking to build wealth faster, taking calculated risks with growthier investments can be a pretty lucrative strategy.

Countless examples of asset classes have provided impressive gains in short time horizons. Yet, it’s important to stress that each carries significant levels of investment risk that can often go beyond an investor’s personal risk tolerance and appetite.

What is a high-risk, high-return investment?

As previously stated, the main attraction of a high-risk, high-return investment is the potential for superior earnings. If everything goes according to plan, investors may be fortunate to double or potentially even triple their money within just a few months or even weeks.

Of course, the greater the potential gains, the lower the probability they’ll be realised. In fact, there are countless examples throughout history where asset prices have surged only to collapse a few days later. In many cases, the crash in valuation has been linked to external factors that weren’t foreseen.

We’ll explore some of the most prominent risks associated with these types of instruments. But first, let’s look at some of the most popular high-risk, high-return investments.

1. Crypto

Cryptocurrency, or digital currency, is an infant asset class that has historically proven intensely volatile. With no tangible asset or value backing these digital tokens, their value is driven entirely by belief. However, some traders are capitalising on this volatility to generate superior short-term returns.

2. Contracts for Differences (CFDs)

These are a special type of derivate that behave similarly to spread betting. An investor can bet on whether an asset’s price will increase or decrease, profiting from the price fluctuation. However, unlike spread betting, buying a CFD is equivalent to buying interest in the price movement rather than the asset itself. Since predicting the minute-by-minute price movement of a security is near impossible, this investment instrument is an exceptionally high risk, especially since traders can lose more money than they initially put in.

3. Penny Stocks

Penny stocks represent tiny publically traded businesses. These young enterprises often have a lot to prove and countless challenges to overcome. In fact, most fail, creating a high-risk proposal for investors. However, the few that succeed can generate gigantic returns for patient long-term investors and impatient short-term traders seeking to profit from volatility.

4. High-Yield Bonds

Companies that have lower credit ratings can still issue junk bonds. These debt instruments are marked below investment grade by credit rating agencies. As such, they are considered a higher risk as there is a greater chance that the issuing company will default on its payments. To compensate investors for this threat, these bonds offer higher yields. Hence the name.

5. Collectables

Investing in collectable items like art and wine is always risky. They are notoriously difficult to sell due to the low number of interested parties, and investors have a high chance of encountering counterfeits. Nevertheless, this alternative asset class can prove to be a lucrative pursuit if the investor is experienced.

6. Leveraged ETFs

A leveraged ETF operates similarly to a regular exchange-traded fund. They track an underlying index and seek to replicate the performance. However, a key difference is that a leveraged fund uses leverage to amplify gains. This can tremendously boost wealth when times are good. However, a sustained downturn in the market can result in significant losses. And since losses compound daily, they often destroy wealth when being held for the long run.

Characteristics of high-risk, high-return investment

A leading characteristic of almost every high-risk investment is that investors can lose all their invested money, sometimes even more. But what are the specific risks that these instruments are exposed to?

• Volatility Risk – In many cases, the value of high-risk investments is hugely dependent on market sentiment and investor confidence. Subsequently, asset prices are notoriously volatile.
• Liquidity Risk – Not every investor has the risk tolerance or interest to delve into high-risk, high-return investment instruments. As such, the pool of buyers and sellers can sometimes be very small, making it difficult to sell an asset. Therefore, even if it has appreciated in value, investors may still have to sell at a significant discount due to a wider bid-ask spread.
• Interest Rate Risk – Sudden movements in interest rates can drastically impact an asset class’s value. Companies that have issued floating-rate high-yield bonds may be unable to keep up with the increased payments triggering a default.
• Political Risk – A change in government policy can significantly disrupt or prevent an asset from reaching its full potential, causing its valuation to plummet.
• Management Risk – An investment vehicle that has a management team at the helm is prone to mismanagement. Unethical or illegal behaviour can drastically diminish the value of a business or fund, resulting in significant losses.
• Credit Risk – Companies that issue debt may be unable to keep up with interest payments, let alone repay the principal at maturity.
• Fraud – Some high-risk, high-return investments exist as an alternative asset class, such as collectables and cryptocurrency. In many cases, this space is unregulated, resulting in a significantly higher level of fraud.

How to research high-risk investments

• Determine Risk Tolerance – Before pursuing high-risk, high-return investments, the first step is determining whether these asset classes are suitable. Investors must establish their investment goals, time horizon, and risk appetite. In many cases, taking on such excessive investment risk may be completely unnecessary to achieve their personal objectives.
• Gather Information – Given the increased likelihood of losing money, making hasty decisions is a recipe for disaster. Investors must research and understand the asset classes they are interested in buying. Investors should steer clear if an asset proves too complicated to understand or analyse comprehensively. Being able to make an informed decision is paramount.
• Speak To An Expert – Professional investment advice can be expensive. But when dealing with complex derivatives or rare collectables, attempting to make money without professional help can often be more expensive. Relying on professionals doesn’t guarantee positive returns. But it could drastically eliminate the possibility of making an error or falling prey to a scam.

What to consider before buying high-risk, high-return investments?

Even after performing all the appropriate due diligence, it’s a sensible idea for investors to run through a safety checklist. For example:

• Investment may be unsuitable and require expert knowledge. Therefore, be prepared to hire the services of professional managers.
• Most investment advisers generally recommend asset allocation of no more than 10% of a portfolio into high-risk, high-return investments, providing it is in line with personal risk tolerance.
• Be wary of potential scams. Many alternative asset classes lack legal and regulatory protection for investors, making it far more common to encounter fraud and scams.
• Be prepared to potentially lose all invested money. Not always, but these investments have the probability of making investors lose all their money.

The bottom line

High-risk investments come with the probability of high returns. However, this type of investment is not suitable for every investor. As a general rule of thumb, it’s good practice to have a small asset allocation in these types of investments to mitigate the downside risk.

This article contains general educational information only. It does not take into account the personal financial situation of the reader. Tax treatment is dependent on individual circumstances that may change in the future, and this article does not constitute any form of tax advice. Before committing to any investment decision, an investor must consider their individual financial circumstances and reach out to an independent financial advisor if necessary.